Aug 1, 2006 12:00 PM, By Susan T. Bart, partner, Sidley Austin LLP, Chicago

By: By Susan T. Bart, partner, Sidley Austin LLP, Chicago

Two recent legislative developments may enhance the attractiveness of Internal Revenue Code Section 529 savings accounts over other methods of saving for higher education expenses for certain individuals. One increased the kiddie tax age to 18; the other changed the federal financial aid treatment of 529 accounts.

First, the Tax Increase Prevention and Reconciliation Act of 2005, signed into law May 17, provides that the kiddie tax now applies until a child reaches age 18. The kiddie tax, which taxes the child's net unearned income over a certain amount ($1,700 for 2006) at the parents' income tax rate (if the parent can claim the child as a dependent) previously applied only if the child was under 14 years old. But now, income earned on assets in a Uniform Transfers to Minors Act (UTMA) account for a child or in a trust for the child that is taxable to the child under the grantor trust rules is subject to income tax at the parents' rate until the child is 18. Of course, parents' income tax rates are usually higher than their children's, so UTMA accounts and trusts taxable to the beneficiary as grantor trusts will likely incur higher-than-anticipated tax burdens until the beneficiaries reach 18.

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